May 2023
Jeff says banks have a fundamentally flawed business model as depositors can leave at any time. Chris also notes that many banks have been locked into long-term bonds or mortgages at low fixed interest rates while borrowing short-term loans themselves. Thus, when the Fed raised rates from zero to 5.25% in a matter of 12 months, banks had to pay a higher interest on the money they were borrowing but were not receiving much more interest from their fixed-rate bonds.
According to Jeff, many banks were too hopeful that rates would never rise and should be more intentional with risk management moving forward. Many people are wondering if more banks will collapse, but Jeff says no one can predict the future. Thankfully, Morton Wealth has always been mindful of the possibility that rates could rise and has prepared in advance by prioritizing resilient and diversified investments.
Chris raises the point that if more regional banks fail and are bought by larger banks, there may be more opportunities in private lending as these bigger banks do not engage as much in creative financing or small business loans. Morton has been invested in private lending since 2009, and Jeff says he is already seeing private lenders charge higher rates.
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Ep. 32 What's Happening in the Los Angeles Real Estate Market
Ep. 31 What You Need to Know About LA's New Mansion Tax
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by CEO of Morton Wealth, Jeff Sarti. Jeff, thanks for joining us.
You’re welcome. Good to be here.
So not my favorite topic to talk about, but in the news recently. It's Thursday, May 4th. So may the forth be with you. But just wanted to bring it up, on Monday, earlier this week, JPMorgan and First Republic went into an agreement to merge together. Right. So it's another bank failure or bank collapse.
Yet another one.
And, you know, I mentioned that today is Thursday, May 4th, because this episode is likely not to get aired until next week. And there are some other banks that are in the news the last couple of days Pacific West Bank. Yeah.
Western Alliance. Both, I think I just saw their stock prices are down again today like 30% or 40%.
So yeah crazy and yeah you know Pac West Bank 90% in the matter of a few business days. Oh is that right? Yeah. And the reason why we want to do a topic on THE FINANCIAL COMMUTE about this is because you know we're following up on the episode that we did not long ago with regards to Silicon Valley Bank and Signature Bank and, you know, the Fed was hoping that this would be contained within just a matter of just a handful of banks.
They've continued to stress the market, raise interest rates. And even on Monday, Jamie Dimon, the CEO of JP Morgan Chase, someone who should know a lot, came out and said, hey, this is the last straw. First Republic's the last one. Like, we should be good from here. I don't know if that was the Fed twisting his arm to actually say something, but wanted your thoughts on what’s going.
You know, I mean, listen, I hope he's right. And I probably even think he's right. If I had to make a bet that this contagion is mainly contained, I hate to have a crystal ball because I don't really know, but I don't put too much credence or thought into his words. He has to say that, right?
He’s the czar of the banking world. So he's trying to stabilize the system. The truth is, no one really knows. And again, we're seeing it today. You're seeing it with these banks, Pac West, Western Alliance. This is the issue around banks. And I think we talk about, Meghan and I talk about this in our recent market review, too.
Banks fundamentally have a flawed business model. You have depositors who can leave at a moment's notice. Excuse me, no one can predict when that's going to happen. So as a nature of that, we don't know if things like Pacific West now or Western Alliance are in trouble. We just don't know.
Yeah, we don't. But Michael Milken is the Milken Conference actually investment conference going on this week. Yeah, He came out earlier in the week and said this is a lesson that banks should have learned from the seventies. Yeah. Right now, these banks that are in trouble, he feels like the larger banks, the JPMorgan's of the world are in a much different situation, a lot better capitalized, a lot safer.
That was Michael Milken’s words.
And that is true. They are, from a regulatory point of view, they are just more insulated in terms of risks, capital ratios, things of that nature, just much safer, much more safely position.
Because a bank run can happen to anybody. Sure. Less likely.
Less likely with those large banks.
But the lesson that he said that people should have learned from the seventies is all of these banks had to basically open up and show, hey, here's the risks that we're exposed to. And we were lending for a long period of time and borrowing short term. Yes, right. So the reason why that was a problem is in the world of zero interest rate policy, when the federal government said no, there's no risk to keeping rates at zero and printing lots of money, everything's going to be fine.
But because of that, these banks were loaning money. Think of 30 year mortgages at 3%. So 30 year loans, very cheap rate. Yep. And then they were borrowing money on the short term. Yep. Because they take in deposits, they have to lend it out. So if they need money to fund deposits or people withdrawals or whatever they have to borrow.
The reason why that became an issue is because all of a sudden, in a 12 month period, the Fed raised the rates from 0 to 5.25%. There was another rate hike this week, and now banks borrowing, the short term borrowing rates is over five. Yeah, but they lent a bunch of money out at you know, two or three.
Not a good economic system for those banks.
Not and part of the frustration and just we've been talking about this for a number of years, the lack of risk management or understanding on the part of these banks, theoretically very sophisticated institutions with robust risk management systems departments. The fact that they didn't see this, the potential for this rising rates, something we've been talking about for years, it’s just kind of mind blowing.
It's really I mean, I hate to be, use sort of extreme words with this, but I mean, they really had their head in the sand. Yeah. For them to just be so cavalier and just hopeful and hope is not a strategy, but hopeful that rates wouldn't rise or could never rise. It's just again, it's kind of mind blowing and it just shows, I mean, the lack of confidence we have in these types of institutions, we should have, it's justified by the actions we're seeing now.
Yeah. And I guess the questions that I'm getting from clients more so than anything, it's kind of two things like is this contained? Yeah, I don't know. Probably not. Could be. But clearly the Fed sees an issue, if they're going to come in and basically force a marriage with JP Morgan Chase, they gave JP Morgan something like a $50 billion loan, to help make this go through with First Republic.
There's some other banks that are having issues. They're hoping that it's contained. Yeah, and it doesn't cause issues. But the reason why a lot of questions are that clients are asking is like, what are the longer term effects? But also why is the market not coming down as much as it might normally be? Sure. Obviously, we don't have all the answers.
We can speculate a little bit. There's a lot more liquidity or money in the system today than in years past. And when you think of the value, when you think of $1,000,000,000,000 and we've talked about this before, you can you can understand or comprehend a million or 10 million or 100 million. You can think of all the things that you'd like to buy and then you get to a billion.
You're like, okay, maybe a football team or a baseball team, right? You get to 100 billion. It's like, okay, well, what does 100 billion buy? And then what does a trillion dollars buy? And the next thing you know what is 30 trillion? That's just so much money and it's got to go somewhere. And that's partly being propped up, propping up the system.
There's no liquidity is undeniably helping keep things afloat, at least for the time being. But back to your point on can this contagion continue? Again, the answer is we really don't know. And I know that's maybe not a satisfying answer for people who are on the other side of this camera right now. Yeah, but this is something I think the most important thing is we don't need to overreact.
This is something we've been thinking about for quite some time. We've been...
As we we're talking about Morton.
Morton. Yeah. Morton Wealth, we've been prepared for these types of risks in advance. Again, we talk about a lot how we didn't buy long term bonds because of our fears of rising interest rates. Another reason why we've been so conservative is that we have known that if rates did rise or when they would rise as they have, there would be collateral damage.
Yeah, we didn't know where would prop up. It could have been with pension systems, it could have been with other investment funds, etc., or it could have been with banks. We're seeing in our banks.
I think we got more of a debt bubble before banks. Sure, yeah, that could still happen.
But the answer is, I mean, we've been prepared in advance. This is why we're so diversified, so in other, positioned in other asset classes that we think will be resilient even if the contagion continues, we even have gold positions, which are doing very well in this type of environment where you have a flight to safety in the gold, as an example.
Yeah, gold has reacted with that safe haven. The fears around, hey, look, nobody wants to live in a world where their cash deposits or their money in a bank is not safe. Yeah. And we definitely don't want pain or recessions or job losses, but that doesn't mean that there aren’t opportunities that come out of this. We've been conservative as an investment firm for quite some time because there is a huge impact of rising rates, and the cost of debt.
So things like gold and our gold exposure is starting to starting to do well. Yeah, this flight to safety. But Michael Milken also stated and it's funny because it's also our view that because of this banking crisis and a lot of these small and medium sized banks do creative financing for construction projects or other types of small businesses that these banks are, it's probably not contained.
We're going to end up with a bunch of JP Morgan's, Bank of America’s of the world that don't do a lot of this lending. So we're likely to end up with a world where more opportunity in private lending exists. Right. And that's kind of what happened in 2008-2009 with our real estate lending that was around, but it wasn't as available prior to 2009.
And so there could be a tremendous amount of opportunities for investment that could come out of this as well.
And this, as you know, I mean, this is our area of expertise. We've been invested in private lending since really the 2009-2010 timeframe. So we are well positioned. And the truth is we're already seeing it because of the exodus of lenders, namely regional banks across not only real estate but lending to corporations and other things as well.
We are seeing our private lenders already stepping in and they have pricing power. They are charging higher rates than they were even just three or six months ago for the same exact loan that they would have made previously. So instead of charging 7% or 8% on a particular loan, they might be charging 9% or 10% without taking on more risk.
We're seeing that. We're seeing that already.
Yeah, it is incredible how quick and dynamic that world is. Being able to do the same loan that you were a year or two ago and make more money or even a more conservative loan and make the same or more money. I mean, that's another way to protect investors.
Absolutely. I mean, to your point, we're not rooting for contagion. That being said, if it does continue and there is more volatility in the marketplace, opportunities will arise. And I think we're well positioned for it.
Thanks, Jeff. I just, we’ll kind of summarize and recap. But, you know, one of the reasons why the market, let's call it the S&P 500 being the market maybe has not reacted as negatively as one might’ve thought, a month or two into several banks going under is really eight or nine companies are propping up the value of call it the market performance this year.
If you take away those top eight or nine companies...
All technology growth companies.
And this is all technology growth companies, we're not going to get into valuations and whether or not that makes sense, but those companies are the reasons why maybe the market hasn't reacted as negatively or you're not seeing it from a performance standpoint. Right. But who knows whether or not this banking crisis in smaller, more regionalized banks is contained, it could continue to happen.
So people need to pay attention to the risks that they're taking on in terms of their exposure to stocks and other, you know, higher octane type of investments. Pay attention to the deposits that you have at the bank. Make sure that it's covered under FDIC insured deposits, because as much as the Fed has come in and backstopped all these banks so far, there might be somebody that they say, you know what, hey, we've drawn a line in the sand.
And that's maybe what they kind of did by saying, Hey, JP Morgan, will you and First Republic get together, is they're starting to realize that because the debt ceiling and some other stuff that we'll get into in another episode about they can't come in and bail out everybody. Sure. So pay attention to your deposits, the risks that you're taking on.
But then don't be afraid to be able to look for opportunities.
Yes. Couldn't agree more. Stay diversified. Stay diversified in a variety of different asset classes where, sure, I mean, some things might run into some trouble, but hopefully those are smaller piece of your portfolio. And in the meantime, other opportunities might arise that we will take advantage of it.
Perfect. Thanks, Jeff.
Disclosure:
Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.
